Employee stock options: Butteriss on human resources
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One of the wealth-creating incentives employees and executives can receive from small and fast-growing companies is the option to purchase company shares or stock options. These plans give employees a chance to participate in the success of the business.
Shares and options can be granted to individuals in a number of ways:
- in lieu of compensation
- as a bonus based on performance
- by means of employees buying the shares at the independently set price
Shares
Most private companies hope that they will be successful enough to launch an initial public offering (IPO) and take the company public, so that its shares can be sold on a given stock exchange. It is hoped that the publicly traded shares will have a higher value, thus allowing employees to sell their shares at a higher price than they paid for them.
Shares in a business are created at the time the company becomes incorporated. They can be expanded at any time in the future and may include different classes of shares. Some shares have voting rights, whereas others do not. Some pay dividends, and some do not. The value of the shares are set by independent outside audits and the share plan itself should be established with the help of a lawyer.
Stock options
Stock options can be granted in the same way that shares are issued. Stock options are an arrangement by which an employee receives the“option,” or right, to buy shares for a specified price during a specified time. Options are granted to an individual at the given price and can be exercised at any time during the agreed-upon term. For instance, the employee may wait until the company has gone public and the shares have risen before he or she chooses to buy the stocks in the option plan at the original set price. In this way the employee can make a substantial gain.
An example of this is a company in the computer industry. Because its profits had been increasing quite rapidly, it decided to give employees with good performance, stock options that would extend for a period of five years. These were given to the individual by the company at the initial price of $50 per share. The employees would then be able to keep the shares or cash them in at the end of the five years. Given the growth rate of the company, it is easy to predict that the $50 shares could well reach the value of $250 at the end of that period. So, clearly, this is a very attractive long-term way for employees to build up cash reserves.
If the company permits a long period from the date of the issue to the last date for exercising the option, this will encourage people to stay with the company and be fully committed to its success.
The advantages and disadvantages of share and stock option schemes
| Advantages | Disadvantages |
| • They increase the commitment of the employee to the company, since they own part of it. | • The value of the shares may not increase, since the company may not be as profitable as hoped: thus, these types of plans and bonuses are a gamble for the individual. |
| • Employees are likely to become more cost- and profit-conscious. | • Shares in a private company must be traded within the firm, which assumes that someone else wants to buy them. |
| • Additional money will be raised for the company as employees buy the shares. | • If shares and options are given out to too many people, the value of the stock can be diluted, making it less valuable than if it were held by only a few people. |
| • There is a potential for employees to increase their wealth as the company becomes more profitable and the value of the shares increases. |
Shares and options in high-tech companies are particularly attractive to younger people, who hope that they have joined the next Microsoft or Yahoo. Many will work for a company for a while to learn new skills, but if they see that it is not going to excel in the long term, they will move on to another company that offers shares and hope that that one becomes profitable.
The tax implications of shares and stock options need to be reviewed by an accountant. Basically, receipt by an employee of a stock option does not give rise to income when the option or share is issued. Tax only becomes payable when the option is disposed of, or exercised—i.e., when the shares are actually bought.
Copyright© 1999 by Margaret Butteriss. All rights reserved. Published by John Wiley& Sons Canada, Inc.
http://www.amazon.ca/Help-Wanted-Complete-Resources-Entrepreneurs/dp/0471643882
References
Butteriss, M. (1999).Help Wanted: The Complete Guide to Human Resources for Canadian Entrepreneurs.Toronto: John Wiley& Sons. pp.118-120
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